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The Shadow Consumer Bankruptcy System

By Alan White

    Bankruptcy filings have not risen at anything like the rate at which consumer debt defaults have risen since 2007.  Part of the explanation may lie in the shadow bankruptcy system, a network of alternative service providers who purport to save debt-burdened consumers from the bankruptcy court.  While consumers being sued on delinquent credit cards and mortgages receive solicitations in the mail from bankruptcy attorneys, they are also deluged with a variety of other offers of aid.  These range from foreclosure rescue scams to a wide range of legitimate and dubious debt advice and counseling services, to debt elimination and debt settlement schemes.  While pondering this post I searched in the usual places for any good empirical data on the number of consumers participating in non-profit counseling, or the number of customers enticed by those who promise to make debt disappear, with no success.   We don't seem to know how many debtors go to these debt advice services.

    The shadow consumer bankruptcy system is similar to, but distinct from, Richard Hynes? notion of an informal consumer bankruptcy system, which consists essentially of delinquent consumers not seeking help at all, from bankruptcy court or anywhere else, because they are adequately protected from creditor enforcement through state exemptions, debt collection statutes and a lack of any assets to seize.   My observation that bankruptcy filings have not kept pace with consumer overindebtedness is congruent with Professor Hynes? observation that civil debt enforcement lawsuits have not kept pace with the rise in consumer debt defaults.  If creditors don?t always sue, and consumers don?t always file bankruptcy, what else is going on?

            Perhaps it is simply a matter of risk-based pricing:  it is cheaper now for the credit industry to write off a certain amount of uncollectible consumer debt and recover the losses through pricing, than to waste resources in futile efforts to enforce all debt contracts.  This possibility leaves open the serious problem of external costs imposed by the hugely increased number of debt defaults, on borrowers, lenders and communities, as well as the question of what impact the shadow bankruptcy services have on debtors and creditors.   Some good research and information on the shadow consumer bankruptcy system would inform the policy debate around the degree of harm and distress caused by excessive consumer debt, and the effectiveness of bankruptcy law and its alternatives in reducing those harms.

Full post as published by Credit Slips on September 29, 2010 (boomark / email).